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Let the Banks Eat Cake

20Sep2011

Written by Michael N Cohen

THE ECONOMY-It’s time to stop them from devouring us.

Have you wondered why so many people, underwater on their mortgages, soldier on under mountains of debt? While in reality to save our cities and towns and the American worker they must do the unthinkable. “You want to fix this economic crisis? You want to put people back to work? You want to light a fire under the economy? The fastest way to fix this mess is to see tens of millions of homeowners default on their mortgages and other debts, and millions more file for bankruptcy”, advises Brett Arends of MarketWatch

Sure, it ticks some off that people got to borrow all that money and won't have to pay it back. It does me. I trudged along for some 15 years paying off my mortgage. But you know what? “The time to stop that happening was years ago, when all that money was being lent.”

It's kaput, gone to what money managers call “money heaven. “

And Chapter 11 by the average Joe and Jane is, by far, the least painful solution to get the USA moving again.

Why?

“Because the real cause of our economic slump isn't too much government or too little government. It isn't red tape, high taxes, low taxes, the growing divide between the rich and the poor, too much government debt, too little government debt, corporations, poor people, "greed," "socialism," China, Greece, the sign of the Zodiac, or the legalization of gay marriage.”

It isn't, in short, any of the things all the various nitwits say it is.

IT'S THE DEBT STUPID!

The private debt owed by us, the American consumer. Not the USA sovereign debt (which, by the way, 2/3 is held by ourselves, we Americans) that was a distraction and political football recently. That doesn’t have jack cheese to do with it.

“We're hocked up to the eyeballs, and then some. We're at the bottom of a lake of debt, lashed to an anchor. The root cause of the financial crisis and the great recession that followed was excessive household debt, which doubled from 2000 to 2008, peaking at nearly $14 trillion, a quadrupling in a generation. We owe more than any other nation, ever.

“More than a quarter of American mortgages are underwater. Many are deeply underwater. In states like Nevada and Florida the figures are astronomical.”

The key thing to understand is that most of these debts will never, ever be repaid in real money. Not gonna happen, no way, no how.

Think! - Corporations when they get into trouble – do what? They get their expensive attorneys to explore the benefits of defaulting on contracts and … bankruptcy, tah dah!

“Illustration: When Company A whose assets and earning capacity will only repay, say, $300 million on a billion dollars in debt? Does Company A soldier on with $1 billion in debt it can never repay? Do the stockholders send back their dividend checks? Do they and management sell their homes to pay off the Company’s bonds?

Not a chance. The company goes through Chapter 11. The creditors fix it real fast. They write down the loans and take what’s left of Company A and move on.”

Why not ditto for homeowners as well?

(NOTE: At the time of this article (9/16/11) according to Bloomberg News citing four unnamed sources, “Bank of America Corp. (BAC) would consider filing bankruptcy for its unit Countrywide Financial Corp. if litigation losses threaten to cripple the parent.”)

If a company defaults, the stockholders get wiped out. If a homeowner defaults, the bank takes the home.

“Some will say the financial impact would be terrible. But the banks would just be facing up to reality. And a lot of these mortgages are already trading at distressed levels.”

“Some will say, 'Why should people get away with borrowing imprudently'?"

“The response: Why should the banks get away with lending imprudently?” says Arends

“There's no point telling people not to borrow money. They always will. Have you seen or heard of a Wall Street executive or Corporate CEO executive turn down free money? Me neither. I have yet to see a company in an IPO say, ‘Don't give us so much money!’ People like money. They will take as much as they are offered.”

In a free economy, the people who are supposed to ration the loans are the lenders. Banks are supposed to lend carefully and responsibly. What else are they paid for? Accepting deposits? You could hire people on minimum wage to do that.”

Some will say, "It’s immoral" for borrowers to default and some may even wistfully recall debtors’ prisons. Sadly though, most of these people are being at worst disingenuous or at best inconsistent.

“ They are usually the first ones to defend a company when it closes down a factory and ships the jobs to China, or pays the CEO $50 million for doing a bad job, on the grounds that this ain't morality, pal, this is business!"

But when Main Street wants to do the same thing, they start screaming "Morality! Morality!"

Hey listen up” “We don't live in an economy based on morals and fairness. “

T Mobile, my wireless carrier, doesn't charge me what's "fair" each month. They charge me according to my contract. And, BTW, their current “deals” beat my existing contract with them by a lot and they won’t let me switch without paying a hefty penalty. And no doubt if the other wireless providers started eating their lunch they’d either sell out or default on their debt as well.

If you ask the boss for a raise so you can pay your bills don’t expect anything but a laugh and maybe shown the door out. You get paid what you’re worth to the company in our capitalist economy.

Did high flying executive Dick Grasso, the former CEO of the New York Stock Exchange who was given a controversial deferred compensation package worth $140 Million, subsequently give back his bonus?

Did Bob Nardelli give back his bonuses and golden parachutes at Chrysler, Home Depot and GE? And who, not so incidentally, was named by CNBC as one of the "Worst American CEOs of All Time"?’

Did Dick Fuld, CEO of Lehman Brothers? - Who received nearly half a billion dollars in total compensation from 1993 to 2007 - Over $22 Million in 2007 alone, just before the company went bankrupt. The list goes on and on.

“We operate in an economy based very firmly on contracts, and nothing else. Companies, and the wealthy, live by the letter of the law. American mortgage contracts allow for default.

“Half of the states in this country are "non-recourse," which broadly speaking means you can send in the keys and walk away from a bad loan.

“The other half are sort of "semi-recourse." The bank can come after you for any shortfall, but only in a limited way.”

Your retirement accounts are generally untouchable. You can keep some personal possessions and typically keep your car, personal effects, life insurance, and annuities.

OJ Simpson had a personal judgment of some $30 Million + against him but his creditors couldn’t touch a penny of the retirement annuity that Simpson acquired during his football career.

“Most of the people who are deeply underwater don't have that much anyway.

“And the banks knew this. When they were lending $500,000 to a bus driver with $1,000 in his checking account, they knew that their loan was only guaranteed by the value of the home.

“If they didn't know it, they should have. Their incompetence is their problem, not ours.

“We have tens of millions who cannot repay their debts. But they are all trying to. That sucks huge amounts of money out of the economy. And that means these people cannot function properly as consumers or workers. That's the reason more people aren't coming into restaurants or haven't hired you to redo the kitchen or do a host of other things.

“And so tens or hundreds of millions of perfectly responsible business owners and employees are also suffering from this slump. That's the big, really big reason we have a shortage of demand and why there is little hiring.”

Even worse: People who are underwater on their mortgage, but who do not want to default, make the job market “sticky”. They simply are not able to pick up and move to where the jobs are. They are stuck in town along with their home

Wouldn’t you agree that we should clean the slate, start over by putting the loans back to the banks by going Chapter 11? So we can face a tomorrow where the good guys and gals get their lives back?

I do not say this lightly. I own financial stocks, Bank of America, Wells Fargo. If homeowners follow the prescription bank valuations may decline sharply. So be it, because what are the alternatives since Banks are unwilling to be proactive and write down mortgages and reduce interest rates across the board? If they had many more homeowners would have had a chance at keeping their homes.

That would have the immediate effect of feeing up their discretionary income which would go back into the economy – which is, after all, 2/3’s of America’s GDP – and not into bank officers’ bonuses.

Or maybe you think we should employ: “Government cutbacks, higher taxes, and a balanced budget? - in a normal economy, fine. But in this situation, when the private sector is also slashing its spending, that could lead to absolute catastrophe. That's what happened in the Great Depression and we’re poised to see that happen again.” Arends goes on.

“And our debt levels are worse than in the Great Depression.”

Government borrowing? "The consumer can no longer borrow like a crazy person," says the Keynesian Economist, "so Uncle Sam has to do so instead." It's just transferring private madness to public madness.

Inflation? Inflation is achieved by printing money, which monetizes the debt and decreases the value of each buck in circulation.

In 2005 the government was on a wild money printing binge to reduce the trade deficit imbalance and to help pay for the Iraq and Afghanistan wars which were consuming massive amounts of cash.

By March 2006 the problem had become so severe that they stopped reporting the M3 money supply numbers! (Note: M3 is broad measure of our money supply) and our deep recession has continued running the printing presses.

“But frankly, that is the least bad alternative to save the country if done in real earnest. But it's just default by another name. And instead of taking money from the imprudent banks that caused the problem, it robs widows and orphans and grandmas of their income and savings.”

Twice before, advanced economies have gone through what we are going through now -- namely a massive hangover after a massive debt binge.

The first was the U.S. in the 1930s; the second was Japan in the 1990s.

The U.S. didn't get out of it until the 1940s unleashed inflation and reduced the debt's value in real terms.

Japan still hasn't gotten out of it. They have deflation, while government debt has skyrocketed.

The correct moral hazard is to punish the banks who lent imprudently by making them eat their own losses. “

Still don’t get it? Well how about this reported in the Dow Jones News Wire on Friday:

“According to a report from the Department of Labor, the whistleblower's investigation in Boston, conducted in 2007, found ‘egregious fraud spread throughout the entire region,’ including forgery of loan documents, manipulation of borrowers assets and income, manipulation of the company's automated underwriting system and destruction of valid documents. The report, which was reviewed by Dow Jones, says the investigation led Countrywide to close three-quarters of its Boston branches and fire about 44 employees.”

Also B of A, Wells Fargo, and Goldman Sachs are being sued by the government for various bad actions (fraud?) and procedures. Likely they will be paying big fines. But don’t expect any of that money to actually help bail out homeowners.

So let’s get on with the cure and swallow the medicine. And you know what? Another long term benefit maybe those banks will think twice by selling us out in the future and maybe treat us all a bit better.

You and I may not like the prescription but the alternatives look worse, far worse for all of us.

(Michael N Cohen was formerly a financial advisor with PaineWebber and United Bank of Switzerland. He is a Board Member of the Reseda Neighborhood Council, and is an occasional contributor to CityWatch. Thanks to Brett Arends of MarketWatch for his insight /quotes, and to Dow Jones, Bloomberg as an information source.) -cw